CAS Indexed Annuity Crediting Strategies and Interest Rate Concepts 1 — Questions and Answers
Question 1: What is the primary benchmark index most commonly used in fixed indexed annuities?
- Dow Jones Industrial Average
- S&P 500 Index (Correct answer)
- NASDAQ Composite
- Russell 2000
Correct answer: S&P 500 Index
The S&P 500 is the most widely used index benchmark in fixed indexed annuities due to its broad market representation and widespread familiarity among consumers.
Question 2: In a fixed indexed annuity, what happens to the policy owner's principal if the linked index performs negatively during a crediting period?
- The account value decreases proportionally with the index
- The principal is protected and no interest is credited for that period (Correct answer)
- The account value is reduced by a contractual floor amount
- The insurer charges a negative return fee against the account
Correct answer: The principal is protected and no interest is credited for that period
A core feature of fixed indexed annuities is downside protection: the principal is guaranteed against market loss, and in a down market period the credited interest is simply zero rather than negative.
Question 3: What is a 'participation rate' in a fixed indexed annuity?
- The percentage of premium allocated to the index strategy
- The percentage of index gains credited to the policy owner (Correct answer)
- The percentage of the surrender charge waived each year
- The percentage of premium returned to beneficiaries upon death
Correct answer: The percentage of index gains credited to the policy owner
A participation rate determines what proportion of the index's positive performance is credited to the annuity owner, for example a 70% participation rate on a 10% index gain yields a 7% credit.
Question 4: Which crediting method calculates interest based solely on the difference between the index value at the start and at the end of a contract term?
- Monthly averaging
- Monthly sum
- Annual point-to-point (Correct answer)
- Daily averaging
Correct answer: Annual point-to-point
The annual point-to-point method compares the index value at two discrete points in time—start and end of the term—ignoring all intra-period fluctuations.
Question 5: What is an interest rate 'cap' in a fixed indexed annuity?
- The minimum interest rate guaranteed regardless of index performance
- The maximum interest rate that can be credited during any crediting period (Correct answer)
- The floor rate applied when markets decline
- The rate used to compute surrender charge reductions
Correct answer: The maximum interest rate that can be credited during any crediting period
A cap limits the maximum interest that can be credited in a period; if the index gains 15% but the cap is 8%, only 8% is credited to the account.
Question 6: In a fixed indexed annuity, what does the 'floor' most commonly represent?
- The minimum guaranteed interest rate, typically 0%, protecting against negative credits (Correct answer)
- The maximum possible credited interest rate for a given period
- The participation rate applied to positive index returns
- The minimum initial premium required to open the contract
Correct answer: The minimum guaranteed interest rate, typically 0%, protecting against negative credits
The floor is the minimum interest that can be credited in any period, usually 0%, ensuring that even in strongly negative market years the policy owner never receives a negative credit.
Question 7: What is a 'spread' (also called a margin or asset fee) in the context of indexed annuity interest crediting?
- The difference between the stated and effective annual interest rates
- An amount deducted from index gains before interest is credited to the policy (Correct answer)
- The additional premium charged when optional riders are added
- The difference between the account value and the surrender value
Correct answer: An amount deducted from index gains before interest is credited to the policy
A spread is subtracted from the index gain before crediting; for example, if the index gains 10% and the spread is 2%, only 8% is credited to the contract.
CAS Indexed Annuity Crediting Strategies and Interest Rate Concepts 1
What is the primary benchmark index most commonly used in fixed indexed annuities?